Wage growth accelerating due to the interplay of several one-off factors

The fact that the wage growth in the first quarter of 2014 at 7.7% in annual terms would exceed the last year's forecast was previously implied by the State Revenue Service data on the breakdown of wages in January and February.

Such a significant wage growth acceleration results from the interplay of several one-off factors.

Tax burden on labour income was reduced this year: social insurance contributions were cut by 1 percentage point and Personal Income Tax allowance was increased. This could have had a positive impact on the wage statistics through both pushing up the total wage bill as well as partly legalising the so-called envelope wages.

As of January 2014, the minimum wage was raised by 12.5%, with the estimated impact on average wage reaching up to 1.5 percentage points.

In the process of the euro changeover, at some companies wages were probably rounded up to whole euro or to round amounts.

Low base: the annual rise of the average wage in the first quarter of 2013 was 0.5 percentage point lower than the average reported in the preceding and the following quarters.

The impact of all those factors is stronger in the private sector. Therefore, it is no surprise that the acceleration of the wage growth is much more substantial in the private sector than in the public sector: 8.7% and 6.1% in annual terms respectively in the first quarter.

In any case, taking into account Latvia's double-digit unemployment rate (should not be confused with the one-digit registered unemployment rate), this acceleration of the wage growth points to the presence of high structural unemployment and the fact that Latvia has already or almost reached its natural unemployment rate. For example, if cyclical unemployment would be currently high in Latvia, the rise in the minimum wage would reduce the workload of the minimum-wage earners rather than increase their pay. Similarly, the wages would not be rounded up to a whole euro and the cuts in labour taxes would benefit employers instead of employees.

The year 2013 was concluded with improved profitability and optimistic expectations enabling businesses to raise wages to a larger extent than usual. While profitability remains on an upward path, there is no reason for concerns that more substantial wage growth could deteriorate the competitiveness of businesses. The assessment of labour shortage is also stable: it is mentioned as a significant impediment to business by 11.4% of manufacturing businesses, 13.2% of construction businesses and 4.5% of service companies which is no more than in 2004. This will prevent the decoupling of the wage growth from the productivity growth. Should the economic growth in 2014 turn out to be more sluggish than it seemed a couple of months ago, this would mostly be reflected in the wage developments during ghe next year.

As the wage growth accelerated on account of several one-off factors, it is likely to decelerate in the second quarter of 2014 both in annual terms as well as seasonally-adjusted quarterly terms. Nevertheless, the annual increase in 2014 will be overall higher than the traditional 4%– 5% as the solid first quarter rise will be reflected in the annual growth also in the coming quarters.